Views from the road: India

28
February
2018

By Mark Evans, Analyst

Mark Evans discusses his recent trip to India and his concerns over the politics, inflation and the capital adequacy of some of the public sector banks.

I recently visited Delhi and Mumbai on a two day tour of India, meeting with a number of public sector officials, local private financial institutions, a political journalist and rating agencies. The timing of the trip was ideal, given the recent presentation of the Budget and the Reserve Bank of India’s (RBI) Monetary Policy Committee meeting.

These research trips are an invaluable part of our proprietary research and analysis, getting the view ‘on the ground’ which we wouldn’t necessarily have by staying at our desks. My trip to India was no different, and while there were lots of learning points, I highlight below the three key takeaways which I think are the most underappreciated by the market.

BJP’s ground a little shakier

With legislative elections due around May 2019, these are now starting to appear on peoples’ radars. While there is a long way to go, the political analyst I spoke with expects the ruling Bharatiya Janata Party’s (BJP) to win the election, but lose its absolute majority by some distance. If this materialises, the BJP will become more reliant on their coalition partners which would likely throw more sand in the wheels of reform, disappointing those with the long held structurally positive view on India.

What was interesting is this loss of appeal appears more directed at the BJP than Prime Minister Modi, whose popularity remains very high. The government officials I spoke with appear very aware of this falling popularity and hence their number one priority for this year is growth. Upcoming local elections will be a good barometer of how much the Modi appeal and growth improvement sticks with voters. Relative to expectations, it feels the risks are skewed to the downside.

Indian Government Bonds – who’s going to buy them?

The local financial institutions I spoke with remain very reluctant to buy Indian government bonds, despite the sharp correction in yields over the last six months. While fundamental concerns are well flagged (higher oil prices, better growth, higher inflation etc), the recent RBI comments suggest they would not interfere in the bond market which effectively prompted a buyer’s strike. To offset this, the local financial institutions are hopeful that the central bank will increase the limit available for foreigner portfolio investors (FPIs) to invest in the bond market from the current 5% level. The RBI is due to announce the new limits towards the end of March/early April. The central bank previously supported increasing these limits providing the fiscal position was improving. However, fiscal consolidation has recently stagnated, and the budget announcement did not offer much comfort. Hence, there could be more disappointment in store for local financial institutions.

Public Sector Banks in dire need of capital boost

It remains well understood that Public Sector Banks (PSBs) in India have significant balance sheet issues which the government is trying to clean up by recapitalising them. Despite these government efforts, my discussions with rating agencies confirmed my previously held view that the magnitude of the recapitalisation is insufficient. This could delay the growth recovery beyond market expectations and add more pressure on the government’s finances through bigger capital injections.

Portfolio positioning

Overall, there is growing uncertainty over the future path of the Indian macro story. There are important external factors to consider (oil prices, Fed policy etc) which can significantly impact the short term outlook for India, but the internal dynamics appear to be deteriorating relative to market expectations. Consequently, we retain our short positions in the currency and interest rate markets (in portfolios permitted to do so).

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